Why Costco's Millenial Strategy Makes a Lot of Sense

Costco's decision to take only small steps as it tries to lure the younger crowd to its stores is a sound one. Drastic changes in retail often turn out to be too jarring for customers, and they can easily damage a company's business.

It's funny how people recently started picking a bone with Costco's (NASDAQ:COST) business model after the leading warehouse retailer missed on top- and bottom-line expectations during its latest earnings call. More than just a few analysts started carping about how Costco was digging its own grave by ignoring millenials in its business strategy. Never mind that prior to the latest quarter, Costco managed to expand its top line at 12% in fiscal 2012, and 6% in fiscal 2013.

In the second-quarter of the current fiscal year, Costco's top line expanded 6% to $26.3 billion, with same store sales growing 5%. Its bottom-line, however, contracted 15.4% from $547 million, or $1.24 earnings per share in the previous year's comparable quarter, to $463 million, or $1.05 earnings per share during the last quarter. Costco blamed weak sales and profits on non-food merchandise, as well as weaker profits on fresh foods, for the lower profit.

Costco's millennial strategyDoes Costco even have a millennial strategy in the first place? Probably not one to write home about. Costco's social media presence speaks volumes about what young people think of the warehouse king. Consider that Retail Wire reported in March of this year that Costco's Facebook page only had 1.1 million likes, versus 34.5 million for Wal-Mart, and 22.7 million for Target. Amazingly, Costco's Twitter page was inactive with no followers, while Target boasted 1.08 million followers, and Wal-Mart had 465,000 followers.

Costco, admittedly, caters to an older crowd -- people with families, and garages that are big enough to hold the mammoth stacks of king-size packs that Costco sells. Most of Costco's stores are also suburban, while younger working folks tend to prefer living in big cities.

But that doesn't mean that Costco is happy with the status quo and has decided to just let things remain the way they've always been. The retailer is slowly taking incremental steps aimed at drawing in a younger demographic, which seems necessary in a digitized environment rife with competing membership programs such as Amazon Prime.

Costco recently partnered with Google to conduct same-day deliveries in the San Francisco Bay area. The project is merely an experiment, but if successful, it could be rolled out to more cities. Costco is also selling more organic foods, such as organic beef and kales, which chief executive Richard Gallanti says help drive in younger customers.

These, admittedly, look like baby steps that might not do much for the retailer that records sales in excess of $100 billion per year. Interestingly, Costco says it will only be taking small steps to pull in the younger crowd, and will avoid making any big moves.

Making drastic changes is not a good ideaCostco's decision not to go flat out for the younger generation might look bit strange since the company has the financial muscle to do it if it so wishes. But retail is a very tricky business, if recent experiences at J.C. Penney(NYSE:JCP)

J.C. Penney used to mark up its goods and then offer hefty discounts, promotions, and coupons to customers. This strategy worked amazingly well until chief executive Ron Johnson decided to scrap the company's pricing policies in favor of ''everyday low prices.'' The new strategy backfired badly as the retailer's large horde of bargain hunters deserted its stores. Store traffic nosedived 25%. To-date, J.C. Penney has never fully recovered.

There are good reasons retail customers frequent the stores they do. In Penney's case, customers simply loved the big discounts. Scrapping that changed the very essence of the company, and customers' love affair with it came to an abrupt end.

Take Costco. Most Costco customers love visiting Costco's warehouses because of the "treasure hunt" hunt experience they provide.

A typical Costco store stocks just 4,000 different brands, as opposed to a typical Wal-Mart store that stocks 10 times as many. For instance, you might only find four toothpaste brands at a Costco store, but about four dozen at a Wal-Mart store. Costco frequently changes the merchandise in its stores so customers can expect something different each time they visit. This contributes to the treasure hunt experience that customers love, and that keeps them coming back.

Costco also marks up its goods just 15%, compared to 25% for the average retailer. Although the company requires people to pay a $55 membership fee for a regular membership, and $110 for an executive membership to shop at its stores, many people do not mind at all, and its membership base has been growing about 8% every year.

Look at TJX Companies(NYSE:TJX). There is a good reason a big percentage of TJX customers are women. TJX offers heavily discounted prices, typically 20%-60% lower than what specialty retailer and department stores charge. You will find women in TJX stores busy schlepping through heaps of marked-down sweaters, but few men bother going there. TJX is, however, happy to let things remain this way, because it knows any drastic changes could spell disaster for it.

Retail customers in general hate changes that are too jarring. If Costco attempted to drastically change its modus operandi in an attempt to look more hip and pull in the millennials, it might end up damaging the brand image it has carefully built over the years. It, therefore, makes more sense for the company to only make small changes and see what works and what does not.

Costco can still reach the youth by offering more of the products they love on its website. Currently, online sales account for just 2% of Costco's sales, leaving plenty of room for growth.

Foolish bottom lineCostco's decision not to do anything too drastic in a bid to catch the youth is a good one, since any major changes in retail tend not to go down well with customers. The company can reach youth more through its online store, rather than trying to lure them into its physical stores.